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    SA 505 - External Confirmations

    Introduction: - 

    An auditor should obtain sufficient appropriate audit evidence in order to give opinion on the true and fair view of financials. Sufficiency and appropriateness of audit evidence shall depend on the assessed level of inherent and control risk of the entity. To assess the level of control risk, we exercise compliance procedures and based on the findings of the compliance procedures and other considerations like materiality, we decide the nature and extent of substantive procedures to be performed. 

    SA-200 “Basic principles governing an audit" (Erstwhile AAS-1) states that, "The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information." 

    External Confirmation is a substantive procedure used to obtain audit evidence. SA-505 deals with “External Confirmations”. The purpose of this Standard on Auditing (SA) – 505 is to establish standards on the auditor's use of external confirmations as a means of obtaining audit evidence. 

    SA 505 is effective for audit of financial statements for period beginning on or after April 1, 2010. 

    Objective: -

     

    This article aims at illustrating few significant aspects explaining the need, procedures for obtain and types of external evidences.

     

    Meaning: -

     

    In general, external confirmation is confirmation obtained from external sources i.e., third parties. As per

     

    SA 505 External Confirmation means:

    üAuditEvidence obtained

    üasadirect written response

    ütotheauditor from a third party

    üinpaper/electronic/other form.

     

    Need for External Confirmation: -

     

    External Confirmation is required to give a true and fair view on the financials of a company and the auditor is required to ascertain whether such financials are free from material misstatements or not. To ascertain that, the auditor is required to obtain sufficient and appropriate audit evidence. He shall obtain such evidence by performing Substantive and Compliance procedures, wherein one of the method of collecting audit evidence is External Confirmation.

     

     

     

     

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    Areas required to be Confirmed: -

     

    External confirmation procedures frequently are relevant when addressing assertions associated with certain account balances i.e., Debtors and Creditors Balances and their elements. However, external confirmations need not be restricted to account balances only. Therefore, any transaction which involves third party can be confirmed depending on its materiality.

     

    For example, the auditor may request confirmation of the terms of agreements or transactions an entity has with third parties. External confirmation procedures also are used to obtain audit evidence about the absence of certain conditions, for example, the absence of a “side agreement” that may influence revenue recognition

     

    Steps involved in obtaining Confirmation: -

     

    The following are the steps involved in obtaining external confirmation:

    üDetermining the information to be confirmed

    üSelecting the appropriate third party

    üDesigning the confirmation requests (Properly addressed also)

    üSending the request including follow-up requests if required

     

    Auditor shall maintain control over external confirmation requests. Maintaining control means maintaining direct communications between the intended recipients and the auditor to minimize the possibility that the results of the confirmation process will be biased because of the interception and alteration of confirmation requests or responses.

     

    Appropriate course of action to be taken by Auditor in the following cases:-

     

    ØIfmanagement refuses to allow auditor to send confirmation request:

    In such case, auditor shall inquire the reasons for refusal

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    If management refusal is reasonable then auditor shall üAssesswhether the reasons are valid

     

    üEvaluate whether there is possibility of risk of material misstatements and

    • Perform alternative procedures.

     

    • Example for alternative procedure: In the examination of accounts receivable, alternative procedures may include examination of subsequent cash receipts (including matching such receipts with the actual items being paid), shipping documents, or other client documentation to provide evidence for the existence assertion.

     

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    SA 505 - External Confirmation

     

     

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    • If the management refusal is not reasonable and auditor is unable to perform alternative procedures, then he shall communicate with those charged with governance and give effect on his report.

     

    ØRelianceon response obtained from third parties to confirmation request: -

    • Auditor shall rely, if there is no doubt about reliability of response.

     

    • However, if he has doubts about reliability of response, he shall obtain further evidences to resolve the doubts.

     

    • If response is unreliable, it may indicate fraud risk factor. He shall consider its effect on Nature, time and Extent of other audit procedures.

     

    How to obtain External Confirmation?

     

    External Confirmation shall be obtained by sending request to third party to confirm the particular matter or amount. There is no standard format for framing request. The confirmation request may be designed to ask if any modifications have been made to the agreement and, if so, what the relevant details are.

     

    The auditor may give a list of accounts selected for confirmation to the management for preparing requests for confirmations, which should be properly addressed and stamped. Alternatively, the auditor may request the management to furnish duly authorised confirmation letters and fill in the names, addresses and other relevant details relating to the accounts selected by him.

     

    The auditor should, however, ensure that it is the auditor who sends out the confirmation requests, that the requests are properly addressed, and that it is requested that all replies and the undelivered confirmations are delivered directly to the auditor. The auditor considers whether replies have come from the purported senders.

     

    Types of Confirmation request: -

     

    Depending on the materiality of the transaction / area for which the confirmation is sought, there are two types of confirmation request

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

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    SA 505 - External Confirmation

     

     

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    ositivPeConfirmation request: -

     

    üMeaning:

     

    • It asks the third party (Confirming Party) o To reply to the auditor

     

    o   In all cases

     

    o Either by indicating agreement/ disagreement with the given information o Or by asking third party to provide information

     

    üAresponse to positive confirmation request is ordinarily expected to be reliable üIfreply to a request is not received in reasonable time, he may send an additional confirmation requested

     

     

    Illustration: -

     

    Dated:

     

    (Name of the Vendor)

     

    Our auditor’s M/s_____ are auditing our Financial Statements and wish to obtain confirmation of accounts payable to you as of March 31,20XX. Please confirm whether this agrees with your records on that date by signing and returning this form directly to our auditors. An addressed envelope is enclosed for this purpose. If you find any difference, please report details directly to our auditors in the space provided below.

     

    Yours Faithfully,

    (Name of the Client)

     

    Address of Auditors

     

     

    The above amount is correct_______. The above amount is incorrect for the following reasons:

    ___________

     

    Yours Faithfully,

    (Third Party)

     

    Other Positive forms, “blank forms”, do not state the amount, but request the recipient to fill the balance.

     

    tivNegae Confirmation request: -

    üMeaning:

    o It asks the third party

     

    • To respond directly to the auditor o Only if there is disagreement

    o with the given information provided in request

     

    üItisconsidered to be less persuasive than the positive confirmation request.

     

     

     

     

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    SA 505 - External Confirmation

     

     

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    Illustration: -

     

    Dated:

     

    (Name of the Vendor)

     

    Our auditor’s M/s_____ are auditing our Financial Statements and wish to obtain confirmation of accounts payable to you as of March 31,20XX. If it does NOT agree with your records, please report the exceptions directly to our auditors. An addressed envelope is enclosed for this purpose

     

    Yours Faithfully,

    (Name of the Client)

     

    Address of Auditors

     

    The above amount is incorrect for the following reasons: ___________

     

    Yours Faithfully,

    (Third Party)

     

     

    When Negative Confirmation are preferred over Positive?

     

    Auditor should use them only if all of following are present: ?Riskofmisstatements is low ?InternalControl is effective ?Itemcontains small amount

     

    ?Lowexception rate is expected

    ?Noreason to believe that recipient may disregard the request.

     

    Non-Response to Positive Confirmation Request: -

     

     

     

     

     

     

     

     

     

     

     

     

     

    • When using a confirmation request other than a negative confirmation request, the auditor, generally, follows up with a second and sometimes third request to those parties from whom replies have not been received.

     

    • Alternatively, auditor shall contact the recipient of the request to elicit a response.
    • Where the auditor is unable to obtain a response, then he shall perform alternate procedures.
    • The alternative audit procedures should be such as to provide the evidence about the financial statement assertions that the confirmation request was intended to provide.
    • However, if he determines that response is necessary & thus alternate procedures do not provide sufficient appropriate evidences, he should determine its effect on audit report

     

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    SA 505 - External Confirmation

     

     

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    Exception: -

     

    It means a response indicating disagreement of third party. Auditor shall investigate exceptions to determine whether these are Indicative of misstatement.

     

    Evaluating the results of Confirmation Procedures: -

     

    ØAfterperforming any alternative procedures, the auditor should evaluate the combined evidence provided by the confirmations and the alternative procedures to determine whether sufficient evidence has been obtained about all the applicable financial statement assertions.

    ØInperforming that evaluation, the auditor should consider

    o the reliability of the confirmations and alternative procedures;

     

    • the nature of any exceptions, including the implications, both quantitative and qualitative, of those exceptions;

     

    • the evidence provided by other procedures and o whether additional evidence is needed.

     

    ØIfthecombined evidence provided by the confirmations, alternative procedures, and other procedures is not sufficient, the auditor should request additional confirmations or extend other tests, such as tests of details or analytical procedures.

     

    Reliability of Audit Evidence: -

     

    ?Thereliability of audit evidence is increased when it is obtained from the Independent source outside the entity i.e., external sources

     

    ?Thereliability of audit evidence that is generated internally is increased when the related Internal controls are strong.

     

    ?AuditEvidence obtained directly by the auditor is more reliable than the evidence obtained indirectly.

     

    ?Auditevidence in documentary form, electronic form is more reliable than evidence obtained orally. ?Auditevidence provided in original documents is more reliable than evidence obtained in

    photocopies.

     

    Conclusion: -

     

    It can be concluded that auditor shall obtain sufficient and appropriate audit evidence by performing substantive and compliance procedures, wherein external confirmations are the part of substantive procedures and then conclude whether financial statements are free from material misstatements (or) not, and give his opinion accordingly.

     

     

    “Great minds discuss ideas, average minds discuss events, small minds discuss people.”

     

    – Eleanor Roosevelt

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